Ambiguous Business Cycles

54 Pages Posted: 27 Jan 2012

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2012

Abstract

This paper considers business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of con fidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in our models work like changes in conditional means. Our models thus allow for uncertainty shocks but can still be solved and estimated using first-order approximations. In our estimated medium-scale DSGE model, a loss of confi dence about productivity works like `unrealized' bad news. Time-varying con fidence emerges as a major source of business cycle fluctuations.

Suggested Citation

Ilut, Cosmin L. and Schneider, Martin, Ambiguous Business Cycles (January 1, 2012). Economic Research Initiatives at Duke (ERID) Working Paper No. 123, Available at SSRN: https://ssrn.com/abstract=1992105

Cosmin L. Ilut (Contact Author)

Duke University ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States

HOME PAGE: http://econ.duke.edu/~cli2/index.html

Martin Schneider

Stanford University ( email )

Stanford, CA 94305
United States